Context:

• India’s low investment in Research and Development (R&D) is often attributed to policy and institutional weaknesses. However, the issue cannot be explained solely through economic structures or cultural factors.
• India’s R&D deficit emerges from the interaction of historical, structural, financial, and political factors, some of which have shaped the behaviour and risk appetite of Indian businesses over time.

Large Domestic Market - A Double-Edged Advantage:

• The “captive market” effect:
  • India’s vast domestic market provides businesses with a large consumer base, reducing the pressure to compete internationally.
  • Firms can achieve growth by serving domestic demand without entering highly competitive global markets.
  • This weakens incentives for technological upgrading, quality enhancement, and frontier innovation.
  • Export competition has historically driven innovation in countries such as South Korea, Japan, and Germany.
• R&D version of “Dutch disease”:
  • Just as resource abundance can reduce industrial competitiveness, a large domestic market may discourage firms from investing in costly and uncertain R&D activities.
  • Key insight: Easy market access can diminish the urgency to innovate.

Colonial Legacy and the Weak Manufacturing Tradition:

• Impact of colonial de-industrialisation:
  • Economic historians have documented how colonial policies undermined India’s indigenous manufacturing sectors, particularly textiles.
  • Traditional manufacturing capabilities were weakened or destroyed. Commercial communities increasingly shifted towards trade, intermediation, and arbitrage rather than production.
• Long-term consequences:
  • The decline of manufacturing ecosystems shaped business preferences and capabilities for generations.
  • Innovation-oriented industrial entrepreneurship remained limited.
  • Business communities became more comfortable with commerce than technological production.

Premature Financialisation of the Corporate Sector:

• Shift from productive investment to financial returns:
  • Financialisation refers to prioritising shareholder returns and stock market performance over long-term productive investment.
  • It is perhaps the most significant factor behind weak R&D spending.
• Lessons from developed economies: Research highlights how major U.S. corporations increasingly diverted profits toward share buybacks and dividend payments, instead of investing in innovation and capability-building.
• The shareholder-value problem:
  • The doctrine of maximising shareholder value often translates into maximising short-term stock prices.
  • This creates disincentives for R&D because research spending reduces current profits, benefits emerge only after 5–10 years, and corporate executives are rewarded based on short-term performance.
• Executive incentives and short-termism:
  • Studies show that stock-option-based compensation encourages earnings management rather than long-term investment.
  • Similarly, research found that publicly listed firms invest less than comparable private firms because of pressure from quarterly financial reporting.

India’s Premature Adoption of Financialised Capitalism:

• A sequencing problem:
  • Countries such as Germany, Japan, and South Korea first built strong manufacturing and technological foundations before becoming heavily financialised.
  • India followed a different trajectory. For example,
    • Financial-market pressures emerged before the country developed deep industrial capabilities.
    • Firms faced incentives to prioritise financial returns over technological investment at an earlier stage of development.
• Consequence: India now exhibits R&D intensity that remains significantly below what is required for its economic and strategic ambitions. 

Democracy, Uncertainty, and Long-Term Investment:

• High uncertainty in a complex democracy:
  • India’s political economy presents unique challenges:
    • Large and diverse electorate.
    • Multiple layers of governance.
    • Competing stakeholder interests.
    • Security challenges from a difficult neighbourhood.
  • These factors make long-term policy and economic outcomes harder to predict.
• Impact on business decisions:
  • Businesses respond to uncertainty by applying higher discount rates to future returns.
  • As a result, investments with distant payoffs appear less attractive, long-term projects such as R&D suffer the most, and firms prefer investments that generate quicker and more predictable returns.
• The R&D dilemma:
  • Research spending requires sacrificing current profits for uncertain future gains.
  • In an environment of high uncertainty, underinvestment becomes a rational business response, even though it harms long-term national competitiveness.

Conclusion:

• India’s R&D deficit cannot be explained by a single factor. It stems from the interaction of:
  • A large domestic market that reduces competitive pressure.
  • The historical legacy of colonial deindustrialisation.
  • Premature financialisation and short-term shareholder capitalism.
  • Political and economic uncertainty that discourages long-horizon investments.
• Addressing the problem requires more than increasing R&D subsidies.
• It demands strengthening manufacturing capabilities, promoting export competitiveness, reforming corporate incentives, and creating a stable environment that encourages long-term innovation-led growth.